All,
On Schweser P.91, they say that FCF models are preferred vis-a-vis dividend valuation models when we are talking about a majority stake. They give out a quick explanation saying that the ability to influence the distribution and application of these cash flows makes it pertinent for controlling shareholders perspective.
Can anyone clarify that?
Thanks!
Basically it claims that if you have controlling stake you can influence the board and decide for instance the amount of dividends to declare. You get to play with the FCFF.
Yeah, but why is that fact supportive of using FCF models and not DDM?
I dont see whats the advantage of being able to decide whats the use of the cash flow being generated in terms of what model to apply for valuation.
Dividends are declared from free cash flows, so think of it as FCF comes before DDM. Even if you have the control package of the firm, how can you know how much dividend to declare? You just pick a random number?
You must first understand how much are the free cash flows and appreciate the fact that dividends must only be a subset of this.
What about companies that do not pay dividends or even do not qoute on stock exchanges (limited liab.co.) and you are supposed to prepare valuation?
Yeah, i understand that. But I still dont see any relationship with the investment being a minority or majority stake.
Maybe because the power of voting dividends at assembly is on majority.
(Otherwise, I haven’t started with Equity session yet…)
It’ll all be revealed in the equity book in the ddm reading.
Can you please clarify to us before hand then? Hehe
Thanks!
Think of it from investor point of view as well.
Suppose you are investing in a X company so basically your interest area will be returns you’ll be getting by way of dividend.
Similarly you are considering to acquire major chunk of shares then definately earning parameters, cash flows and all would be your prime concern.